Infant Formula Value Chain Part of the NZPECC dairy value chain project January 2014 v1.00 This information was prepared by Coriolis solely for the use of our client; it is not to be relied on by any third party without prior written consent. About Coriolis’ services Coriolis is a boutique management consulting firm that focuses on food, consumer packaged goods, retailing and foodservice. Coriolis advises clients on strategy, operations, organization, and mergers and acquisitions. We develop practical, fact-based insights grounded in the real world that guide our clients decisions and actions. Founded in 1999, Coriolis is based in Auckland, New Zealand and works on projects across the Asia Pacific region.. WHAT WE DO We help our clients assemble the facts needed to guide their big decisions. We make practical recommendation. Where appropriate, we work with them to make change happen. HOW WE DO IT Our style is practical and down-to-earth. We try to put ourselves in our clients’ shoes and focus on actions. We listen hard, but we are suspicious of the consensus. We provide an external, objective perspective. We are happy to link our fees to results. WHO WE WORK WITH We only work with a select group of clients we trust. We build long term relationships with our clients and more than 80% of our work comes from existing clients. Our clients trust our experience, advice and integrity. Typical assignments for clients include… FIRM STRATEGY & OPERATIONS: We help clients develop their own strategy for growing sales and profits. We have a strong bias towards growth driven by new products, new channels and new markets. PO Box 90-509 Auckland, New Zealand Tel: +64 9 623 1848 www.coriolisresearch.com MARKET ENTRY: We help clients identify which countries are the most attractive – from a consumer, a competition and a channel point-of-view. Following this we assist in developing a plan for market entry and growth. VALUE CREATION: We help clients create value through revenue growth and cost reduction. TARGET IDENTIFICATION: We help clients identify high potential acquisition targets by profiling industries, screening companies and devising a plan to approach targets. DUE DILIGENCE: We help organisations make better decisions by performing consumer and market-focused due diligence and assessing performance improvement opportunities. EXPERT WITNESS: We provide expert witness support to clients in legal cases and insurance claims. We assist with applications under competition/fair trade laws and regulations. 2 This research was commissioned by the New Zealand Board of the Pacific Economic Cooperation Council (NZPECC). The research is designed to improve understanding of Global Value Chains (GVCs) which are an important feature of how business organises itself globally. How do you define a global value chain? For this research, GVC is taken to mean the chain of market interactions along which returns from the final consumer of a product are divided among all participants that have contributed to that final product. Different terms are used. “Supply chain” can be taken to emphasise the physical logistic systems involved in international commerce; “value chain” is more common in business contexts but can be confused with rhetoric about “added value” and reasonable questions about what is “value” and what is “cost”; Asian discussions are increasingly using “international production networks” which has the virtue of not privileging any part of an international production system. Why is the research being conducted? Improved understanding of GVCs is potentially crucial for New Zealand's attempts to lift exports’ share of GDP. A better understanding of where and how our exports are used as ‘inputs’ to the production and exports of other countries, whether simply as food or more directly as inputs that form part of other final products, and the options for maximising return to the New Zealand economy, can inform policy to grow New Zealand exports. On top of this a more in-depth understanding and focus on GVCs has the potential to re-frame the trade policy debate - away from: imports are bad, exports are good; to recognition by our trading partners that competitively priced imports are essential for a country to be a successful participant in the modern global economy. NZPECC needs to get a better appreciation of the possible trade policy implications of these trends and developments. Considering the same product through two different value chains: i.e. as a commodity product that feeds into further manufacturing in another country and the same product that undergoes further manufacturing in New Zealand to the stage where it is delivered and ready to consume in another market. The two commodities to be analysed are: UHT milk Infant formula Analysis will include the mapping of respective GVC’s, calculation of representative costs through identification then sourcing of all relevant and material individual components e.g. capital investments, materials sourcing, financing, supply chain and if appropriate brand development costs. (B) Analysis of factors that motivate the choice of position in respective GVC’s of the representative products identified above and why that is it judged to be optimal. (C.1) Drawing on the results of the preceding analysis, and building on existing research, identify the barriers for NZ firms/industries to move to grow their value or capture a bigger share of the total available value; highlight how firms have become engaged in GVCs; and (C.2) Drawing on all the foregoing, and to the extent possible, identify the main implications for future government policy, especially in the areas of services and regulatory reform; how a coordinated ‘think value chain’ approach might be pursued across policy issues under negotiation; and where business could appropriately be involved to help identify policy constraints and provide critical data. What is the structure and scope of the research? Specifically the research must address the following four broad questions: About NZPECC The Pacific Economic Cooperation Council (PECC) is a non-governmental body, serving as a regional forum for cooperation and policy coordination in the Asia Pacific to promote regional economic growth and development. The New Zealand Committee of the Pacific Economic Cooperation Council is a founding and active member of the PECC community. It works to gain strong business and institutional links into the Asia Pacific market and to tie public policy theory and research into practical business outcomes for New Zealand. (A) Detailed and comprehensive description and analysis of the value chain in some representative key NZ exports, particularly in the Asia-Pacific. In relation to dairy, the research would focus on: A representative basic commodity powder namely Milk Powder in the Asia Pacific region. PECC was formed in 1980 and now has 26 Member Committees. Each Member Committee brings together leading thinkers, and decision makers from government, academia and business in an informal setting to discuss and formulate ideas on the most significant challenges facing the Asia Pacific. Against this background, NZPECC has commissioned this research, which is designed to focus on commercial realities and implications for companies and government policies. PROJECT STRUCTURE While this document acts as a stand-alone analysis of the global infant formula value chain relevant to New Zealand, it is part of a wider NZPECC project; the first section of this research looks at the strategic situation I. Infant formula global value chain research II. UHT milk global value chain research Separate document A. Strategic situation facing the New Zealand infant formula industry - What is the big picture? - What is the global situation? - Where are New Zealand firms currently positioned? - Why are New Zealand firms positioned where they are? - What barriers do New Zealand firms face in infant formula specifically? Client brief section B and parts of C1 III. Insights for policy makers Separate document B. Detailed and comprehensive representative global value chain for infant formula - Develop a detailed and representative value chain for New Zealand milk powder from the farm through to retail sale of infant formula to the consumer - Non-New Zealand production - New Zealand production - Mapping, modelling and costing Client brief section A 4 KEY FINDINGS & CONCLUSIONS - GLOBAL Infant formula is a tough industry, with strong barriers to entry, undergoing consolidation; China is the main exception, but signs there point to a rapidly normalising playing field Infant formula is one of the most complex foods in existence. It is an engineered food designed to mimic human breast milk as closely as possible. Infant formula sits on the dividing line between food and pharmaceuticals. This is indicated by the fact that the industry has historically been dominated by major pharmaceuticals firms (Abbott, Wyeth, BristolMyersSquibb, GlaxoSmithKlein, Numico). From a business point-of-view infant formula is a highly attractive activity, as it is a highly defensible category. This defensibility derives from (1) product complexity, (2) economies of scale, (3) patents and other intellectual property, (4) the importance of doctors in the sales process, (5) global regulations (e.g. bans on advertising) and (6) widespread government market intervention (e.g. two-thirds of all infant formula in the United States is purchased by the United States Department of Agriculture’s Special Supplemental Nutrition Program for Women, Infants and Children (WIC)). This defensibility has let to a highly consolidated global market dominated by a handful of multinational companies. Consolidation is even more pronounced at the national or regional level with almost all markets structured as three or four key firms, typically some subset of the global firms and, perhaps some vestigial regional brands, and a few small niche brands (e.g. organic, goat). The industry is currently undergoing terminal consolidation with the multinational companies merging also including the remaining small regional players until stopped by competition authorities. Recent major deals include Nestle buying Pfizer’s infant nutrition unit for US$11.9b in 2012 (Pfizer having itself bought Wyeth) and Danone buying Numico/Nutricia for €12.3b in 2007 (Numico itself being the result of a decade plus industry roll-up). To put these number in perspective, Fonterra has a current market capitalisation of US$8.7b. The main exception to this ongoing consolidation is China, which is similar to developed markets 100 years ago. In China a wide range of players competing, including all the major global multinationals, the major local dairy firms (Mengniu, Yili, others), regional start-ups (BeingMate, Biostime, others) and a huge range of smaller firms. Much, if not all, of the current action and excitement in the New Zealand infant formula industry can be seen as a result of this situation in China. However the Chinese government appears to be “taking steps” to bring order to the market: “According to local reports, the Ministry of Industry and Information Technology (MIIT) has indicated that it hopes to reduce the number of manufacturers to 3-5 firms with revenues exceeding CNY50bn (US$8b) by 2018.” Just-Food, August 16, 2013 The industry dynamic is also changing. As product innovation has slowed and as production technology has diffused more widely, the industry is becoming more similar to other foods and barriers to entry are falling. The future looks set to be a battle between the multinationals leaders and the primarily Chinese newcomers for control of Asia. 5 KEY FINDINGS & CONCLUSIONS – NEW ZEALAND New Zealand is in the midst of an infant nutrition boom and the industry has attracted strong investment New Zealand has a long history of integration into global infant nutrition value chains. Historically (and still in volume terms) New Zealand has primarily been a supplier of dairy ingredients to the industry rather than a producer of finished product. New Zealand is the largest exporter of low/no fat milk powder in the world (and has been among the top five exporters for the past 50 years). All major infant nutrition firms in the world buy raw materials from New Zealand. In the 1950’s, when Wyeth and Mead Johnson built infant nutrition plants in the Philippines, the New Zealand Dairy Board was a trusted supplier. As a more recent example of the importance of New Zealand to the global infant formula value chains, Abbott disclosed that its plant in Guangzhou, China uses 100% NZ milk. While the Glaxo (“The food that builds bonnie babies”) part of GlaxoSmithKlein was founded in Bunnythorpe, New Zealand in 1904 to make infant milk products, the firm exited domestic production in the mid 20th century. Up until 2003 New Zealand produced a small amount of infant formula domestically, had minimal infant formula exports and export growth was low. Global #2 Nutricia (now Danone) acquired and operated locally founded Karicare, but the industry was decidedly sleepy. The situation changed in around 2003 when Fonterra invested in improved/upgraded wet processing and contract packing operations. Over the next decade the New Zealand infant formula industry experienced rapid growth. Fonterra has moved strongly up the value chain from ingredient milk powder into (1) bulk base infant formula powder, (2) contract packing retail product for others (e.g. Nestle) and (3) is now moving into retail of Fonterra-branded products. The success of Fonterra encouraged other New Zealand dairy firms to move into infant nutrition. Westland, Synlait, Sutton Group and New Image now also manufacture bulk infant formula powder. More recently three of the four largest dairy companies in China – Yili (greenfields), Mengniu (greenfields), and Bright (Synlait) - have invested in infant formula plants in New Zealand. The availability of bulk infant formula in wholesale quantities in New Zealand from Fonterra, etc. has let to the rapid emergence of a canning industry populated with a nimble and efficient group of contract packers. This in turn – in combination with the “Wild West” conditions in the Chinese market - has led to the emergence of a huge number (100+) of smaller “pure play” firms selling and marketing infant formula from New Zealand. At the same time, the Dairy Goat co-operative has quietly been pursuing a successful niche strategy building on the unique properties of goat infant formula. The New Zealand infant nutrition industry is an interesting microcosm and one of the best examples of the country’s ongoing move up the value chain. There has been significant investment in the industry over the past decade – in the order of $900m to $1b - and exports continue to grow. While the future is full of opportunities, there are clouds on the horizon, particularly in China. 6 STRATEGIC SITUATION The current strategic situation in the New Zealand infant formula industry is driven by both the global situation and NZ firms strategic directions; this sections explores these GLOBAL SITUATION NZ FIRMS STRATEGIC DIRECTIONS Highly defensible category Co-ops moving up the value chain from ingredient milk powder into base infant formula powder Dominated globally by a handful of multinationals and some vestigial regional brands In terminal consolidation (multinationals rolling up remaining small regional players until stopped by competition authorities) Except in China which is similar to developed markets 100 years ago where a wide range of players are competing - Global category leaders (Nestle, Danone, Abbott & Mead Johnson) - Local dairy firms (Mengniu, Yili, others) - Regional start-ups - Local small firms (Rats & mice) However the Chinese government appears to be “taking steps” to bring law and order to the market Fonterra moving into contract packing finished product for multinational companies Fonterra planning to move into selling branded infant formula in Asia Three large Chinese dairy firms investing in integrated wet/dry IF plants in New Zealand Dairy Goat co-op pursuing a successful niche strategy A few better financed start-ups dry blending or wet/dry blending (e.g. Sutton, New Image, GMP) Huge number of smaller “pure play” sales and marketing only firms (100+) 7 WHAT IS INFANT FORMULA? Infant formula is made from a mixture of dairy and other ingredients and is designed to mimic human breast milk as closely as possible; while made to a common international codex, formulations & ingredients do vary EXAMPLES: Ingredients in Abbott Similac and Nestle NAN HA Gold 2 infant formula (2012) Water, Nonfat Milk, Lactose, High Oleic Safflower Oil, Soy Oil, Coconut Oil, Galactooligosaccharides, Whey Protein Concentrate. Less than 2% of the Following: (43 listed ingredients) C. Cohnii Oil, M. Alpina Oil, Beta-Carotene, Lutein, Lycopene, Ascorbic Acid, Soy Lecithin, Monoglycerides, Potassium Citrate, Calcium Carbonate, Potassium Chloride, Carageenan, Ferrous Sulfate, Magnesium Chloride, Choline Chloride, Choline Bitartrate, Taurine, m-Inositol, Calcium Phosphate, Zinc Sulfate, Potassium Phosphate, d-Alpha-Tocopheryl Acetate, Niacinamide, Calcium Pantothenate, L-Carnitine, Vitamin A Palmitate, Cupric Sulfate, Thiamine Chloride Hydrochloride, Riboflavin, Pyridoxine Hydrochloride, Folic Acid, Manganese Sulfate, Phylloquinone, Biotin, Sodium Selenate, Vitamin D3, Cyanocobalamin, Salt, Potassium Hydroxide, and Nucleotides (Adenosine 5’Monophosphate, Cytidine 5’-Monophosphate, Disodium Guanosine 5’-Monophosphate, Disodium Uridine 5’-Monophosphate). Enzymatically hydrolysed whey protein (milk), maltodextrin, vegetable oils, minerals (calcium phosphate, magnesium chloride, calcium chloride, potassium chloride, sodium chloride, ferrous sulphate, zinc sulphate, copper sulphate, calcium carbonate, manganese sulphate, potassium iodide, sodium selenate), omega LCPUFAs (DHA from fish oil, AA), acidity regulator (citric acid), L -phenylalanine, vitamins [sodium ascorbate (vit C), d-l alpha tocopheryl acetate (vit E), retinyl acetate (vit A), niacinamide (niacin), phylloquinone (vit K), cholecalciferol (vit D3), calcium pantothenate, thiamine mononitrate (vit B1), pyridoxine hydrochloride (vit B6), riboflavin (vit B2), folic acid, cyanocobalamin (vit B12), biotin ], L-histidine, nucleotides (cytidine 5 -monophosphate, uridine 5 monophosphate, adneosine 5-monophosphate, guanosine 5 monophosphate), culture (bifidus, thermophilus), L-carnitine,antioxidant (ascorbyl palmitate). Source: nestlebaby.com.au; abbottnutrition.com; various online shopping websites; photo credit (fair use; low resolution; complete product/brand for illustrative purposes); Coriolis analysis PAGE 8 HOW IS IT SEGMENTED? Infant formula is typically defined as “birth to six months”; the product is then renamed for a range of reasons (primarily to avoid regulation and restrictions on advertising) Five stage segmentation of infant/child nutrition products Model; 2013 Stage 1/Step 1 Common name Stage 2/Step 2 Infant formula Stage 3/Step 3 Infant formula Follow on formula Follow up formula Regulatory environment - Highly regulated - Advertising banned (by law or voluntarily) - Manufacturers focus on selling through doctors & nurses - Defined target age range Birth to 6mo. 6mo. to 1 year Stage 4/Step 4 Stage 5/Step 5 Pregnant mothers Children’s nutrition Toddler formula “Growing up milk” Less regulated as it is not the only source of food (baby is eating solids) Advertising allowed Traditional FMCG sales & marketing “take advantage of brand loyalty developed in Stages 1 and 2 to retain consumers as they grow older” 1 to 3 years 3 to 6 years 6 years + - Regulated as dairy - Advertising allowed Pregnant & lactating women EXAMPLE range: Source: photo credit (fair use; low resolution; complete product/brand for illustrative purposes); Coriolis from a range of published sources 9 HOW IS THE MARKET STRUCTURED? Infant formula is one of the most consolidated food products globally; the top five firms account for 56% of the world market; however there are an emerging group of Chinese firms challenging the world order Baby food/infant nutrition global market share by firm (US$m; 2013) Data here is infant formula and baby food ; IF is ~70% of global baby food category value Store brands 1% Nestlé 23% Other 28% Top 5 Multinational 56% Top 6 Chinese Challengers 6% EU/USA/Japan Regionals 6% Danone 13% Wonder Sun 1% Yili 1% Daqing 1% Yashili 2% Biostime 2% Beingmate 3% Meiji 1% Morinaga 1% Hain Celestial 1% Hero 1% Mead Johnson 10% Heinz 3% Abbott 6% Friesland 2% Hipp 2% Source: Euromonitor; Coriolis analysis PAGE 10 IS THERE A TYPICAL MARKET STRUCTURE? Markets are typically structured as three or four key firms and a small other Baby food/infant formula market share by select market % of sales; 2013 Other 4% Heinz 20% Nestle 12% Other 25% New Zealand Egypt Abbott 6% Source: Euromonitor; Coriolis analysis Philippines Nestle 48% Danone 30% Other 15% Venezuela Nestle 44% Mead Johnson 43% Danone 64% Heinz 24% Other Abbott5% 4% Other 16% Abbott 3% Danone 6% Nestle 55% Other 25% India Saudi Arabia Nestle 46% Abbott 11% Nestle 74% Danone 19% 11 WHAT ABOUT CHINA? China is the main exception and the infant formula market there is still highly fragmented; much of the current action and excitement in the New Zealand infant formula industry can be seen as a result of this situation Baby food/infant nutrition market share by firm in China (US$m; 2013) Nestlé 12% “According to local reports, the Ministry of Industry and Information Technology (MIIT) has indicated that it hopes to reduce the number of manufacturers to 3-5 firms with revenues exceeding CNY50bn by 2018.” Just-Food, August 16, 2013 Heilongjiang Dairy Group 0% Only NZ firm registers in the data; Healtheries has more share than Fonterra Other 20% Future Food 0% Healtheries 0% China Wahaha 0% Dairy 0% Eastwes 0% Wei Chuan 0% Bright is a shareholder in Synlait Mead Johnson 10% Bright Food 0% Yaolan 1% Ausnutria 1% Hunan Yahua 1% Synutra 1% China Wissun 1% Danone 10% Plant in NZ American Dairy 2% Wonder Sun 3% Yili is building an IF plant in New Zealand Abbott 4% Yili 4% Heinz 3% Daqing 5% Mengniu 6% Mengniu is building an IF plant in New Zealand Source: Euromonitor; Coriolis analysis Beingmate 9% Friesland 1% Abbott said all the milk for its Chinese IF plant comes from NZ Friesland is a shareholder in Synlait Biostime 6% 12 WHERE IS GROWTH COMING FROM? Industry growth is almost non-existent (after inflation) in the developed world; China is driving world growth, growing +50% more than the rest of the world combined; however strong growth across the developing world Growth in baby food/infant nutrition sales by global region (US$b; 2004-2009) Absolute Change (08-13) $60.0 $50.0 China Hong Kong Indonesia Vietnam Thailand Philippines Other E/SE Asia $40.0 $30.0 +$10.8 +$1.5 +$1.3 +$0.5 +$0.3 +$0.4 +$0.7 Middle East & Africa +$1.7 Eastern Europe +$2.0 Australasia +$0.4 Western Europe -$0.7 North America $10.0 +$1.5 Latin America $20.0 China+HK +$12.3 +$0.2 Everywhere Else +$8.3 $2008 Source: Euromonitor; Coriolis analysis 2009 2010 2011 2012 2013 PAGE 13 INVESTMENT There has been significant investment – in the order of $900m to $1b – in the New Zealand infant formula industry over the past decade Identified investments in Infant Formula production plant and capacity in New Zealand 1980-2013+ Date Firm Plant location Investment Action 2003 Dairy Goat Co-op Hamilton $16m - Spray drying plant built at Gallagher Drive, Hamilton site 2006 Dairy Goat Co-op Hamilton N/A - Dry Blending plant built at Gallagher Drive site 2007 Fonterra Waitoa Canpac Kauri Darnum (AU) $72m - Investing $71.8 million in +33% increase nutritional milk-powder production, which is mainly devoted to baby and toddler formulas (from 90,000 to 120,000 tonnes) - Fonterra “seeing "double-digit growth" in nutritional powders in Asia due to strong birth rates, and was signing global supply agreements with up to five major international marketers” 2011 Westland Hokitika N/A - Infant formula (base formula), follow-on formula and growing-up milk 2011 New Image Group Paerata, South Auckland N/A - Spray dryer designed for the powder production of specialised colostrum and milk materials for use in nutritional formulations; New Image operates four sites across Auckland encompassing the entire production chain 2011 Synlait (Bright/Mitsui) Dunsandel, Canterbury $100m - Infant formula plant 2012+ Gardians (Sutton Group + Paterson Corp.) Balclutha, Otago N/A - Infant formula plant 2013 Westland Rolleston, Canterbury N/A - Various nutritional milk based products (e.g. infant formula, growing up milk powders etc.) 2013 Dairy Goat Co-op Hamilton $67m - Second powder dryer; four times the capacity of existing plant 2014+ Mengniu/Yashili Pokeno, Waikato $212m - Infant formula plant 2014+ Inner Mongolia Yili Glenavy, South Canterbury $214m - Infant formula plant at acquired Oceania Dairy site (47,000t at full capacity) Source: various published articles & press releases 14 SEGMENTATION We propose the following six potential strategic positions for firms in the infant formula industry EXAMPLE: Simplified model of six possible strategic positions for firms in the infant formula industry Model; 2013 High 3 2 1 Bulk formula production Regional player Multinational leader Volume of product sold (Implies scale) 5 Contract Canner/Packer 4 Niche products 6 Pure Sales & Marketing Low Low Average mark-up per unit High (implies profit per unit) Source: Coriolis 15 WHY? A firm’s strategic position is a function of the factors available to leverage; all positions are obviously not available to all firms 1. Multinational Leader 2. Regional Player 3. Bulk Formula 4. Niche 5. Contract Canner/Packer 6. Pure Sales & Marketing Did you invent infant formula?       Have you been doing R&D leading to NPD for 100 years?       Are you a global leader in the category?       Do you own global brands?       Do you spend a lot of money marketing to consumers globally?       Do you have a large salesforce regularly visiting all channels?       Do you have lots of money? Can you get more?       Are you really good at spray drying? Do you have scale?       /      Is the countryside around your factory picturesque?       Do you have enthusiasm and entrepreneurial vigour?       Are you located close to low cost milk? Source: Coriolis  Leverage   High Medium Low 16 STRATEGIC POSITION Firms in all identified strategic positions can be identified in New Zealand EXAMPLE: Simplified model of six possible strategic positions for actors in the infant formula industry Model; 2013 High 3 2 1 Bulk formula production Regional player Multinational leader Volume of product sold (Implies scale) 5 Contract Canner/Packer 4 Niche products 6 1 Pure Sales & Marketing Low Low Average mark-up per unit High (implies profit per unit) 1. Other examples of a niche position, though not in NZ, is organic (e.g. Bellamy’s Organic baby food in Tasmania); Source: Coriolis 17 1. MULTINATIONAL LEADERS Two of the global top six infant formula manufacturers now own infant formula factories in New Zealand, two others have product contract packed in the country; Mead, Abbott, Morinaga and Meiji all buy from NZ Top 11 global baby food/infant formula multinationals and their identified activities in New Zealand (if any) As of August 2013 Global revenue Global Employees Ownership Nestle CHF92.2b 339,000 Danone 1 Multinational leader Do they source raw dairy ingredients from New Zealand? New Zealand infant formula activities Publicly listed Switzerland - Yes, lots - Contract packed by Fonterra €19.3b 101,000 Publicly listed France - Yes, lots - Factory in New Zealand Mead Johnson US$3.9b 5,600 Publicly listed USA - Yes, lots - No factory; likely buys base powder Abbott US$38.9b 70,000 Publicly listed USA - Yes, lots - No factory; likely buys base powder - Potential to build a plant in NZ ??? Heinz US$11.6b 32,200 Private equity USA - Yes, lots - Contract packed by Fonterra Freisland Campina €10.3b 22,000 Co-operative Netherlands - Not much - Acquired 7.5% share in Synlait Aug 2013 Hipp €1.1b 1,200 Private Germany - Primarily baby food not IF - Hero CHF1.5b 4,000+ Private Switzerland - Not much - Hain US$1.7b 3,670 Publicly listed USA - Primarily organic IF in the US; no NZ market access - Morinaga ¥594.2b 5,710 Publicly listed Japan - Yes - No factory; likely buys base powder - Potential to build a plant in NZ ??? Meiji ¥1,109.2b 15,338 Publicly listed Japan - Yes - No factory; likely buys base powder - Potential to build a plant in NZ ??? Firm Source: Coriolis from a wide range of sources 18 1. MULTINATIONAL LEADERS New Zealand has a high comparative advantage in dairy but is embedded in a relatively small regional market Relative comparative advantage vs. size of regional market in dairy products 1 Model; 2013 Multinational leader China Large Europe United States Singapore Ukraine Canada Japan Argentina Size of regional consumer expenditure on product Uruguay Kenya Cuba Australia New Zealand Barbados Small Tonga High Source: Coriolis Comparative advantage in key raw materials The bottom 119 milk producing countries in the world together produce as much milk as New Zealand Low 19 1. MULTINATIONAL LEADERS Historically multinational manufacturers built plants in regions of large “home” markets with comparative advantage in dairy; more recently they have built plants in large markets with low comparative advantage Relative comparative advantage vs. size of regional market in dairy products 1 Model; 2013 Multinational leader China Large HISTORICAL Europe United States Canada RECENT Singapore Ukraine Japan Argentina Size of regional consumer expenditure on product Uruguay Kenya Cuba Australia New Zealand Barbados Small Tonga High Source: Coriolis Comparative advantage in key raw materials The bottom 119 milk producing countries in the world produce as much milk as New Zealand Low 20 1. MULTINATIONAL LEADERS The behaviour of both Mead Johnson and Abbott demonstrate this model EXAMPLE: Location of infant formula/baby nutrition plants of Mead Johnson and Abbott Nutrition Multinational leader 1 As of August 2013 1910’s 1920’s-1940’s 1950’s 1960’s 1970’s 1980’s 1990’s 2000’s 2010’s Evansville, IN United States Zeeland, MI United States Mexico City, Mexico Manilla, Philippines - Nijmegen, Netherlands Guangzhou, China - Singapore SE Asia - - Singapore Jiaxing, China Guangzhou, China Argentina1 - - Chonburi, Thailand Reason for location - Near raw materials Near consumers - Near raw materials Near consumers Columbus, OH United States - Near consumers - - - - Near raw materials Near consumers - 1. Acquisition; Source: Coriolis from various published articles and reports Near raw materials Near consumers Zwolle, Netherlands Cootehill, Ireland Brockville, Canada Reason for location Sturgis, MI United States Near consumers Competitive manufacturing - CasaGrande, AZ United States - - Granada, Spain1 - Near raw materials Near consumers - Near raw materials Near consumers - Near raw materials Inside EU - Near raw materials Near consumers - Near consumers Near consumers Near consumers Near consumers 21 1. MULTINATIONAL LEADERS When multinational leaders build infant formula plants in markets accessible to New Zealand dairy product, New Zealand firms’ sales to those market then grow EXAMPLE: Import volume of milk powder into the Philippines by source country Kg; millions; 1962-2012 180 160 1 Multinational leader Both Wyeth (now part of Nestle) and Mead Johnson build infant nutrition plants in the Philippines in the mid-60’s; following this, the country’s imports of milk powder, from New Zealand and elsewhere, increased1 140 Other Europe Canada 120 100 USA 80 60 Australia 40 20 New Zealand 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 1981 1980 1979 1978 1977 1976 1975 1974 1973 1972 1971 1970 1969 1968 1967 1966 1965 1964 1963 1962 Plant Upgrade 1. Obviously for a range of uses not just infant formula; Source: UN Comtrade database (custom job); Coriolis analysis and classification 22 2. REGIONAL DAIRY Three of the top four largest dairy companies in China have or are building infant formula production plants in New Zealand; however the main Chinese pure-play IF manufacturers appear to be investing in Europe Details of Chinese dairy firms activities in New Zealand 2 As of August 2013 Position in Chinese dairy market Global revenue Global Employees #1 milk producer in China by sales and volume Firm Regional dairy Ownership New Zealand (and other) investments Websites CHY 43.5b US$7.0b 57,800 Publicly listed - Granted approval to build Infant Formula plant in New Zealand http://www.yili.com/ #2 milk producer in China by sales and volume CHY 36.16b US$5.9b 30,000 COFCO 19% + others (COFCO revenue US$28.2b) - Recently acquired infant formula maker Yashili for HK$12.5b (NZ$2b) - Yashili planning to open infant formula plant in New Zealand (in Pokeno) - JV with Arla (Denmark/Sweden) for yoghurt venture - JV with Danone (France) and COFCO for yoghurt venture http://www.mengniuir.com http://www.yashili.hk #4 milk producer in China by sales and volume Group US$7b (11) State owned parent http://www.brightfood.com http://www.brightdairy.com Bright Dairy CNY14.16b NZ$2.4b 3,680 Subsidiary Publicly listed - Owns 39% of NZ’s Synlait Dairy - Sources raw materials from NZ’s Synlait for China - Bought Weetabix (UK) - Bought Manassen Foods (Australia) - Reported in talks to acquire largest dairy in Israel (Tnuva) for US$1.3b Investing elsewhere BeingMate #1 Chinese owned Infant Formula brand - Investing €20m into production venture with Kerry in Ireland Biostime #2 Chinese owned Infant Formula brand - Investing €20m into production venture with Isigny Sainte Mere in France Synutra #9 Chinese owned infant formula brand - Investing €100m into production venture with Sodiaal in France Source: Coriolis from a wide range of sources 23 3&4. BULK FORMULA/NICHE PRODUCTION Six New Zealand firms now produce and wholesale bulk base infant formula powder Identified firms in New Zealand producing bulk/base infant formula 3 2013 Year Founded Year began producing base IF powder Bulk formula production Do they… Wholesale bulk base formula? Can & contract pack for others? Sell branded infant formula? Current predominant strategic position 2001 Predecessor 1980’s Yes Yes (only large) Launching Bulk formula Developing brand 1989 2003 Yes (goat) Yes (goat) Yes (goat) Niche products 2000 2011 Yes No (?) Yes Bulk formula Developing brand 1937 2012 Yes No No Bulk formula 2011 2012 Yes Yes (Sutton) Yes Bulk formula Developing brand 1984 2011 Yes Yes Yes Bulk formula Developing brand 4 24 5. CONTRACT CANNING/PACKING New Zealand has a wide range of infant formula dry blenders and canners, most of whom contract pack for others Identified firms dry blending and canning Infant Formula in New Zealand 1980-2013+ 5 Contract Canner/Packer Firm Plant location Employees Action Website Fonterra/Canpac Hamilton 251-500 Manufactures and prints can packaging for a wide range of dairy-based consumer products and food packaging. Contract packaging services and can printing http://www.fonterra.com Sutton Group/Gardians Airport Oaks, Auckland 101-250 - Wet, dry and canning http://www.suttongroup.co.nz/ GMP Pharmaceuticals East Tamaki, Auckland 150 - Dry blending and canning http://www.gmp.com.au/ Alpha Laboratories Mt. Wellington, Auckland 150 - Dry blending and canning http://www.alphalabs.co.nz/ Danone/Nutricia Mt. Wellington, Auckland 51-100 - Dry blending and canning http://www.nutricia.co.nz/ Health Pak Penrose, Auckland 51-100 - Pack small sachets http://www.healthpak.co.nz Dairy Goat Co-op Hamilton 51-100 - Wet, dry, canning http://www.dgc.co.nz/ Unitech Industries Henderson, Auckland 80 - Dry blending and canning http://www.unitech.co.nz/ New Image Avondale, Auckland 21-50 - Dry blending and canning http://www.newimageasia.com/ Doxcon Pharmaceuticals Henderson, Auckland 21-50 - Dry blending and canning http://www.doxcon.co.nz/ New Zealand Nutritionals Christchurch 21-50 - Dry blending and canning http://nznutritionals.co.nz/ New Zealand New Milk Auckland Airport, Auckland N/A - Dry blending and canning http://nznewmilk.co.nz/ New Zealand Food Packing Rosedale, Auckland N/A - Dry blending and canning http://www.nzfoodpacking.com/ Source: various published articles & press releases; Food & Beverage Information Project; Coriolis 25 6. PURE SALES & MARKETING New Zealand has 100+ brands of infant formula being sold by “pure play” sales & marketing firms EXAMPLES: Select pure-play sales & marketing organisations infant formula brands from New Zealand Presence; as of August 2013 6 Pure Sales & Marketing 26 GROWING EXPORTS New Zealand infant formula exports continue to grow, reaching ~NZ$400m in 2012 New Zealand infant formula and related valued-added milk-based powder exports by value NZ$m; declared value FOB; 1988-2012 $800 $700 $600 Non-Infant functional milk powders Anlene, Anmum, bodybuilder shakes, etc. HS1901-90-0928 $500 “Milo”, “Nesquick”, other cocoa-based powders HS1901-90-0100 $400 $300 Retail infant formula HS1901-10-0090 $200 $100 Infant milk powder, added sugar HS0402-29-0001 Infant milk powder, no added sugar HS0402-21-0001 $1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: Statistics New Zealand Infoshare database (custom job); Coriolis analysis and classification 27 PROJECT STRUCTURE The second section of this report looks at a representative global value chain for infant formula I. Infant formula global value chain research II. UHT milk global value chain research Separate document A. Strategic situation facing the New Zealand infant formula industry - What is the big picture? - What is the global situation? - Where are New Zealand firms currently positioned? - Why are New Zealand firms positioned where they are? - What barriers do New Zealand firms face in infant III. Insights for policy makers Separate document B. Detailed and comprehensive representative global value chain for infant formula - Develop a detailed and representative value chain for New Zealand milk powder from the farm through to retail sale of infant formula to the consumer - Non-New Zealand production - New Zealand production - Mapping, modelling and costing formula specifically? Client brief section B and parts of C1 Client brief section A 28 KEY FINDINGS & CONCLUSIONS – DETAILED VALUE-CHAIN The value chain for infant formula is complex and every participant earns their returns A range of key findings and conclusions come out of this analysis of the global infant formula value chain: 1. The value chain for infant formula starts with the consumer not the primary producer of any ingredient or raw material. The whole value chain moves, responds and adapts based on day-to-day purchase decisions made by millions of global consumers. Obviously these signals become muffled the further one gets from the consumer, but they cannot be ignored. 2. Most food & beverage categories are not like wine. In most categories, including infant formula, the consumer signals to the retailer that what they want is to choose from among a small number of large, well marketed brands manufactured by well known and trusted multinationals that have been in business for 100+ years .1 3. All actors in the value chain have clearly defined roles and responsibilities. There is a common industry structure and value chain globally - with the same actors and roles occurring everywhere - signalling strong forces creating this structure. 4. Economies of scale are real. The firms in the value chain beyond New Zealand are large scale entities typically with a market capitalisation larger than Fonterra. 5. There is no wide and undefended pool of profitability sitting anywhere along the value chain just waiting to be devoured. At all stages of the chain, firms earn their profits through hard work, innovation, and execution. 6. More defensible positions – with strong barriers to entry – are more profitable and less defensible positions with lower barriers to entry are less profitable. 7. Deep and defensible industry profit pools – typically located around activities at scale - are protected by huge balance sheets. 8. Pro rata on a per can basis, the total infant formula value chain requires $44 worth of total assets to sell an product worth $44. This suggests that selling a lot more infant formula (e.g. to a new emerging market like India), will require a lot more assets in the total chain. 9. Shareholder’s return are generally proportional to assets, particularly across an economic cycle. 10. Stages of the chain beyond the farm gate and basic dairy processing are typically structured – in any given market or segment - as a small number of large firms, rather than a large number of small firms, signalling strong economies of scale. 11. The high defensibility and asset intensive nature of many positions further along the value chain acts as the single largest barrier to New Zealand firms changing position. 1. This is not to say the retailer does not have an incentive to reduce range but fundamentally in any given category the depth of choice offered is driven by the consumer 29 VALUE CHAIN MODEL The value chain for infant formula can be represented by the following simplified model Simplified value chain for infant formula manufacturer Model; 2013 Dairy ingredients Milk powder Whey protein Lactose Wet processing - Some ingredients processed wet Evaporator Spray dryer Marketing - Customers To healthcare professionals To consumers (highly regulated) Doctors/Nurses Mothers Non-Dairy ingredients Vegetable oils Minerals Vitamins (~45+ in total) Other relatives Dry blending - Some ingredients processed dry Dry blending equipment Sales - Healthcare professionals Retailers Channels Government agencies1 Hospitals Pharmacies Package Supermarkets Tin (traditional) Plastic (emerging) Discounters Cardboard carton Canning & packing - Canning line Packing for distribution and export Shipping carton for transport Logistics - Warehousing Order fulfilment Distribution management Documentation Online Other Support functions Procurement - Sourcing Buying Support R&D - Product improvement Packaging improvement Process improvement Patents & other IP - Management Accounting & Finance Legal Human Resources Engineering Note: Not all transport and logistics functions show on this diagram 1. For example two-thirds of all infant formula in the United States is purchased by the United States Department of Agriculture’s Special Supplemental Nutrition Program for Women, Infants and Children (WIC) 30 INFANT FORMULA – THREE STAGES Abbott’s Nutritional plant in Cootehill Ireland gives a real world example of a tight, concise infant formula value chain in action EXAMPLE: Real world value chain for Abbott Nutrition plant in Cootehill, Ireland 2012 or as available Plant in Cootehill Ireland Opened 1975 250-300 employees Nutrition Products Manufacturing Milk collection & processing Turnover €184m (NZ$310m) Founded 1901 1,050 farmer shareholders Ireland & N. Ireland 500m litres 2 processing sites: Monaghan town site Artigarvan site (new 2012) 63% of volume to domestic market and Irish Dairy Board 37% of co-op volume - Vegetable oils Minerals& Vitamins Other (probiotics, etc.) Package - Some ingredients must be processed wet Wet processing area Evaporator Spray dryers (2) Dry blending - Abbott has ~70,000 employees globally - Sold by Abbott global salesforce to doctors, hospitals and retailers around the world - Markets Global Salesforce 97% of plant production is sold outside Europe More than one third of its output is sold in South East Asia - One quarter goes to the Middle East - 12% each to China and Latin America - Canning line Packing for distribution and export - - Canning & packing Some ingredients must be processed dry Dry blending equipment Smaller amounts are sold to Israel, Canada, and Africa Support functions Tin (traditional) Plastic (emerging) Procurement - Sourcing Buying Source: Coriolis from a range of published accounts and sources Support R&D Cardboard carton Shipping carton for transport - Completely integrated facility; houses extensive laboratory facilities, process control systems and enterprise planning systems In operation 7 days per week, 24 hours per day, 3 x 8-hour shifts per day; only shuts down for the summer and Christmas shutdown periods for maintenance, normally for 2 week periods. Compliance to world-class systems i.e. ISO 9001:2008, ISO 22000, PAS220,ISO 14001, Abbott Corporate and Division Policies and local procedures; up to 150 quality control checks Meeting all applicable legislative, regulatory and customer Food Safety requirements through an effective Food Safety Management Programme Abbott doubled the capacity of the plant in 2006 with an investment of €88.5m Wet processing Non-Dairy ingredients Sales & Marketing - Product improvement Packaging improvement Process improvement Patents & other IP - Management Accounting & Finance Legal Human Resources 31 INFANT FORMULA – DIFFERENT MODELS In New Zealand there are a range of models in place for splitting up this value chain EXAMPLE: Simplified production process and supply chain 2012 or as available Milk collection & processing Wet processing Dry blending Canning & packing Sales & Marketing EXAMPLE Abbott in Ireland EXAMPLE Abbott in Singapore Base powder to NZ multinational factory Contract packed for global firm Local canner to smaller marketer … and a few others… … and 100+ others Local canner & marketer Integrated or Source: Coriolis from a range of published accounts and sources 32 INFANT FORMULA VALUE CHAIN – MODEL This analysis of the infant formula value chain uses a simplified value chain from the consumer in Asia through to the dairy farmer in New Zealand; at key stages as far as possible we use real firm’s financials as models Ingredients & raw materials Shelf-ready Products Money Consumer Retailer Infant formula manufacturing, sales, marketing, & advertising In-Market Logistics Source: photo credit (iStock for project; various corporate promo shots; courtesy Westland); Coriolis analysis Dairy Processor Seafreight Logistics Dairy farmer New Zealand Logistics 33 INFANT FORMULA VALUE CHAIN – MARKUP BY STAGE Preliminary analysis of the infant formula value from retail in Asia through to the farm gate return shows most of the value being added beyond the New Zealand border Waterfall chart of value chain from retail shelf price of a can of infant formula through to farm gate value to dairy farmer in New Zealand NZ$; actual; 2012 $47.50 $3.33 $13.25 $0.31 $25.58 $0.43 Retail Source: Coriolis GST Retailer Singapore logistics Manufacturer Freight & insurance $1.91 $2.69 Dairy processor Dairy farmer New Zealand border INFANT FORMULA VALUE CHAIN – MARKUP VS. EBITDA VS. ASSETS REQUIRED Looking beyond markup by stage, into profitability (EBITDA) and nominal assets required to achieve the profit highlights relative returns along the chain; the low return of dairy farmers on their farm value stands out MODEL: Value chain of a nominal “can of infant formula”: markup to stage prior, EBITDA and assets required NZ$; actual; 2012 100% $44.18 (ex-GST) $12.03 $43.83 $5.21 $13.25 $3.09 $0.15 In-market logistics $21.36 90% Retailer Infant formula manufacturer 80% $0.02 70% $0.31 60% 50% 40% $25.58 $7.43 $0.22 $1.36 Seafreight & insurance Dairy processor 30% 20% 10% 0% $15.53 $0.43 $1.91 $2.69 Markup to prior stage Source: Coriolis Dairy farmer $0.03 $0.27 $1.18 EBITDA Pro rata per nominal can Total Assets 35 RETURN ON ASSETS Looking at return on assets we find that all members of the value chain earn their returns Return on assets by stage of value chain %; EBITDA to total assets; model 29% 17% 16% 15% 9% 7% Retailer In-market logistics Multinational infant formula manufacturer Seafreight & insurance Dairy processor in New Zealand Dairy farmer in New Zealand Excludes returns on land value which have been very significant over the past decade; suggest factoring in land value change over the last decade would double this number. Source: Coriolis 36 VALUE CHAIN: THE CONSUMER Our model value chain for infant formula starts with the consumer; in this case “the Wong family”, a typical Singaporean consumer of infant formula Christopher, Fann & Ong Wong A “typical Singaporean family” They are a dual income household with two working parents and one child. He works as an engineer and she works as an administrator in a mid-sized firm They make the average Singaporean household income, which is about $86,000 after tax. They rent an 3 room flat from the Singaporean Government’s Housing and Development Board (HDB) as do 85% of Singaporeans. Ong (the consumer) was born six months ago and is in day care, as Fann (the customer) can’t afford not to work. As a result Ong is fed infant formula. Source: Singapore Department of Statistics “Report on the Household Expenditure Survey 2007/08”; adjusted for income growth to 2012; photo credit (iStock for project); Coriolis analysis AVERAGE HOUSEHOLD EXPENDITURE The average Singaporean household spends about S$3,900 per month, 22% goes on food; almost two-thirds of food expenditure is on eating out away from home; dairy products account for 4% of food spend Average Singaporean household expenditure per month Average Singaporean household expenditure per month on food & bev. S$; % of S%; 2012 est S$; % of S%; 2012 est Recreation & Educational culture services Communi - $339 $207 cations 9% 5% $187 5% Fresh fruits $31 4% Fresh veg. Other $332 9% Other away $15 2% Fast food $28 3% Transport $616 16% Total = $842/month Away $527 63% Health $207 5% Furnishings /repairs $168 4% Housing /utilities $874 22% Meat $56 7% At home $316 38% Food $842 22% Total = $3,900/month $39 5% Rest. & café $141 17% Clothing $129 3% Hawker, food court $342 41% Source: Singapore Department of Statistics “Report on the Household Expenditure Survey 2007/08”; adjusted for income growth to 2012; Coriolis analysis and estimates Seafood $59 7% Dairy $32 4% Eggs $5 1% Oil/fats $9 1% Rice $15 2% Bread $17 2% Other foods $20 2% Non-Alc Bev. $21 3% Alcoholic bev. $12 1% 38 IMPACT ON SPENDING Ong consumes a can of formula per week meaning the family spends about S$176 per month on infant formula; this had led to less spending elsewhere in the family budget Model: incremental food at home spending S$; % of S%; 2012 est $492 +50-60% Ong Wong (The consumer) $59 $56 $39 Fruit At S$46/can= S$176/month Seafood Vegetables 1x900g can/week 4x900g can/month Other foods Bread Rice Oils & fats Eggs Dairy $31 Alc. bev Non-alc bev. Typical Source: photo credit (purchased from iStockphoto.com for project); Coriolis analysis Infant formula $316 $12 $21 $20 $17 $15 $9 $5 $32 Meat Consumes $176 Wong family 39 DOCTOR’S INFLUENCE ON BRAND DECISION Fann buys Abbott’s Similac brand for Ong as this was recommended to her by her doctor, whom she consulted with when she decided to stop breastfeeding; Ong’s doctor is visited regularly by salespeople from the major infant formula suppliers in Singapore “Our sales force educates health care professionals about the benefits of our infant formula products in each of the countries where we market our infant formula products. Primary marketing efforts for infant formula products are directed toward securing the recommendation of the Enfa family of brands by physicians or other health care professionals. and other health care professionals, hospital group purchasing organizations and other integrated buying organizations. Our sales force receives training on our products and customer service skills. We focus our product detailing efforts on neonatal intensive care units, physicians 2012 Source: photo credit (purchased from iStockphoto.com for project); Coriolis analysis We support health care professionals by organizing continuing medical education programs, symposia and other educational interfaces.” p6, Mead Johnson 10k, 40 SALESFORCE FOCUS The major global multinationals put a large part of their selling effort into health practitioners rather than retailers (as in normally the case in FMCG/CPG1); they are doing this as it works to sell product EXAMPLE: Mead Johnson global salesforce by focus target market for selling # of employees; 2010 Visit and sell to healthcare professionals 1,350 71% “Prior to 1988, infant formula was marketed strictly as a pharmaceutical product. Given historical product loyalty, formula makers offered their products free to pediatricians and hospitals in the hopes that the first formula a mother used would be the one she continued to purchase. ” Funding Universe Visit and sell to retailers 550 29% Total = 1,900 salespeople worldwide … and many, many more around the world 1. FMCG = Fast Moving Consumer Goods; CPG = Consumer Packaged Goods; (aka. Things with a bar code you put in a shopping cart); Source: Mead Johnson prospectus; Coriolis analysis 41 VALUE CHAIN: THE RETAILER - WHERE THEY SHOP Like most people, the Wong family shop at the closest supermarket to their home – in their case a Cold Storage near the MRT station; Cold Storage is the #2 chain in Singapore Supermarket market share by chain in Singapore % of supermarket/hypermarket sales; 2012 The Wong family’s local supermarket 10% Others 4% 39% 47% Source: photo credit (Cold Storage press photo); Coriolis from various published reports and accounts CONSOLIDATED MARKET Singapore, like most markets its size, has a highly consolidated retail environment; Cold Storage is owned by Dairy Farm and the company owns and operates a range of stores around Singapore Major retail food store operators in Singapore (2010) Year founded # of stores Ownership Group sales Store formats Firm/Concept summary Website 1973 106 (s/h) Co-operative S$2.1b (2011) FairPrice (95) [SM] FairPrice Finest (7) [SM] FairPrice Xtra (4) [HM] FairPrice Xpress (18+) [CS] Cheers (120+) [CS] Foodfare [Foodservice] Owned by National Trades Union Congress (NTUC) itself owned by 60 unions (550,000 members) www.fairprice.com.sg www.cheersstore.com/ 1903 111 (s/h) Dairy Farm (HK) ~S$1.7b (estimate) Cold Storage (39) [SM] Market Place (6) [SM] Shop N Save (59) [SM] Giant (7) [HM] 7-Eleven (549) [CS] Guardian (135) [Ph] Singapore operations of Dairy Farm (listed; Hong Kong); former owner of Woolworths NZ www.coldstorage.com.sg www.gianthypermarket.com.sg www.7-eleven.com.sg http://www.guardian.com.sg 1985 23 Private (Lim Hock Chee) S$0.5b (2009) Sheng Siong (23) [SM/HM] Food Courts (5) Local chain started by former wet market pork seller www.shengsiong.com.sg 1984 19 Private N/A Prime (19) [SM] Mid-sized supermarkets www.primesupermarket.com 1972 (SG) 4 Listed (SGX); 60% Japan parent S$0.3b2 (2010) Isetan (4) [DS] Scotts (1) [SM]1 Japanese department store chain; 1 has supermarket www.isetan.com.sg 1973 1 Private (Mustaq Ahmad) N/A Mustafa 1 [DS/HM] Indian entrepreneur expands from clothers store to department store w/food www.mustafa.com.sg 1 Japan N/A Meidi-Ya 1 [SM] Fresh food imported directly from Japan (!); other products local & imported www.meidi-ya.com.sg www.meidi-ya-store.com 1. Inside Isetan Orchard store; 2. Includes non-food sales; Supermarket (SM), Hypermarket (HM), Convenience store (CS), Department store (DS), Pharmacy (P) Source: various company websites; various company annual reports; published articles and websites; Coriolis analysis and estimates PAGE 43 WHO OWNS THEIR SUPERMARKET? Dairy Farm International is a multinational retail group based in Hong Kong with stores across the East/South East Asia region; Dairy Farm operates a range of store formats beyond supermarkets Operational structure of Dairy Farm International in Asia US$m; As of FY2012 Sales $9,801m OP $518m Total Assets $3,851m North Asia Sales $4,997 OP $312 Hong Kong Macau SM 302 CS957 HBC 374 R 584 H3 HM SM CS HBC R H China East Asia Sales $2,864 OP $94 South Asia Sales $2,275 OP $113 Taiwan Malaysia Indonesia Vietnam Brunei Singapore HM 75 SM73 HM 46 SM 142 CS 151 HBC 266 HM 1 SM 273 HM 1 SM 2 HM 8 SM 115 CS 570 HBC 151 CS 587 HBC 187 R 122 HBC 400 HBC 16 HBC 22 Cambodia Philippines India SM 7 HM 10 SM 23 SM 62 HBC 88 R9 H4 Hypermarkets Supermarket Convenience Stores Health & Beauty Stores Restaurants Home furnishings (e.g.Ikea) Source: various Dairy Farm publications and reports; Dairy Farm websites; Coriolis analysis 44 DAIRY FARM SHARE PRICE Dairy Farm International’s share price has shown reasonable growth over the past decade and the company has a current market capitalisation of US$14.9b (or 172% of Fonterra’s current market cap) Dairy Farm International share price US$; SG: D01; 10 years Current market capitalisation US$14.9b Source: bigcharts.com (chart); ft.com (DFI and Fonterra market cap); Oanda (exchange rate NZ$ to US$); Coriolis analysis 45 INFANT FORMULA RANGE Cold Storage stocks 14 different Stage 2 formula items from six different global multinationals; Fann begins the value chain by spending S$47.45 on Similac Range of Stage 2 infant formula stocked by Cold Storage Singapore August 2013 800-900g $40.50 $46.25 1.6-1.8kg $40.50 $48.75 $43.90 800-900g $73.90 $42.75 $92.25 1.6-1.8kg $43.05 $41.45 $37.55 $82.05 300g $56.10 $47.45 $89.95 $17.25 Source: Cold Storage online website (accessed August 2013); photo credit (fair use; low resolution; complete product/brand for illustrative purposes); Coriolis analysis 46 MODEL SUPERMARKET COST STRUCTURE Two thirds (65%) of the selling price goes to the supplier, one fifth (21%) goes to pay for the staff, rent, utilities and other costs; a 4% EBIT goes to shareholders and 8% goes to government RETAILER MODEL: Estimated model of net selling price through to shareholders return of a can of infant formula sold through a Singapore supermarket S$; actual; 2012 Financials given here based primarily on the financial data of: Wages $3.98 8% Operating costs $10.16 21% Rent $1.77 4% Cost of sales $30.92 65% Advertising & promotion $1.33 3% Gross Margin 28% Total = $47.50/can Utilities $0.88 2% Supplies $0.44 1% Administration $0.44 1% Other expenses $0.88 2% Shrink /theft $0.44 1% GST 7% GST $3.33 7% Depreciation and amortisation $0.80 2% Finance $0.05 0% Net profit to shareholders and retained earnings $1.89 4% Corporate Tax $0.35 1% EBITDA $3.09 7% Return on total assets (EBITDA/total assets) 17% Tax $3.67 8% Source: Dairy Farm International annual report 2012; past Coriolis research; Coriolis estimates and anlysis 47 MODEL COST STRUCTURE – SUPERMARKET – SOURCES & KEY ASSUMPTIONS The model cost structure used for the retail component of a 900g can of infant formula was built using the following sources and assumptions RETAILER MODEL: Details of key elements and assumptions in model cost structure 2012/13 Issue Details Key data source(s) used - Key assumptions - Modelling a retail price of S$47.50 per can leading to a S$40.92 average annual wholesale price paid by the retailer and a retail gross margin of 28% plus 7% GST - GST of 7% applies to retail shelf price of infant formula in Singapore; ignoring GST from here on in the value chain (assuming it is a wash) - The overall retail P&L cost structure and profitability of a retailer selling 18,000-20,000 items can be used to represent pro rata the cost structure of a specific item (900g infant formula can) from sales value (ex. tax) through to shareholder return - Sales consist of the net value of goods sold to customers, net of returns, discounts and sales taxes Not modelled - Promotional and advertising allowances not modelled, as from the point-of-view of the retailers accounting sales are net of these (in other words we are assuming an average annual net net price) Transport from stage prior - Assuming product is delivered to store by truck - Cost paid by retailer is inclusive of delivery - Delivery is paid by supplier and comes out of their SG&A Dairy Farm Annual Report 2012 (Dairy Farm is #2 supermarket retailer in Singapore) Dairy Farm website and advertising Other Singapore retailer’s annual reports, websites and advertising; various published articles Industry interviews; guidance from reviewers 48 VALUE CHAIN: THE MANUFACTURER - ABBOTT NUTRITION – PLANT IN SINGAPORE The can of Similac that Fann purchased from Cold Storage supermarket was manufactured in Abbot Nutrition’s plant in Singapore, built in 2007 at a cost of US$280m (equivalent to the total assets of Westland) Abbott Nutrition plant in Singapore (Opened 2008) “[Abbott’s Singapore plant] is is the largest investment ever made by the company in nutritional products, as well as its first major investment in Asia and the biggest investment made by a single company in a nutritional plant in Singapore. The facility employs over 300 people. The facility produces 45 million kilograms of powder nutritional products, including infant formula, follow-on formula and growing-up milk. It serves one million infants and children in Asia annually. The products from Abbott are shipped to China, Hong Kong, Indonesia, Malaysia, Philippines, Singapore, Taiwan, Vietnam and the Middle East… Abbott says its decision to set up facilities in Singapore was prompted by the availability of skilled workforce, food safety and quality standards, and infrastructure such as ports. In addition, the AMS nutritional facility enables faster shipment of products to Asian countries… The facility is completely integrated and houses extensive laboratory facilities, process control systems and enterprise planning systems. The manufacturing process at the facility involves wet processing, evaporation, spray drying, blending and packaging. Wet processing involves mechanically removing the outer skin of the raw material. The raw material is then dried up. The spray drying process is used to produce dry powder with the help of hot gas. infants and children. It manufactures Similac, Gain, Gain Plus, Grow, Grow School and PediaSure Complete. Similac is a nutritional product intended for infants aged up to six months, while Gain is for babies aged six months and older. Gain Plus targets children aged one year and above. It is intended to help in visual as well as physical development, support the growth of brain and increase immunity. It also provides prebiotics to maintain a healthy digestive system. Grow is nutritional milk, which helps in the physical and cognitive growth of children aged three years and above. Grow School is also a milk product for children aged six and above. PediaSure is a complete nutritional product, which helps growing children aged one to ten. The plant is located in the Tuas Biomedical Park II (TBP). TBP II is a 188ha facility located at Tuas View, 20 minutes from Jurong Port, Singapore. Situated in the west end of Singapore, TBP is a biomedical manufacturing centre that houses facilities of important world players in the biomedical field. The centre includes all the necessary amenities and infrastructure such as roads, power lines and telecommunication lines.” Food Processing Technology website, accessed Aug 2013 [The plant] produces nutritional products for Source: photo credit (Abbott promotional photo); Abbott Singapore; other published accounts; Coriolis analysis Key operations: Wet processing Evaporation Spray drying Blending Packaging Infant formula Other nutritional powders Brands: Similac Advance®, Gain®, Pediasure® and Grow®. Key raw materials: skim milk powder (100% imported) lactose oils cans cardboard packaging US$280m (S$450m) Location: Tuas Biomedical Park 2, Singapore Floor area: Produced: Investment: 52,222 square metres Year opened: 2008 Employment: 300+ people PAGE 49 ABBOTT NUTRITION – LOCATION OF PLANTS The Singapore plant is one of 14 Abbott Nutrition manufacturing plants around the world Location of Abbott Nutritionals plants (2012) Sligo, Ireland Zwolle, Netherlands Brockville, Canada Cootehill, Ireland Granada, Spain Fairfield, California Jiaxing, China Guangzhou, China Casa Grande, Arizona Sturgis, Michigan Tipp City, Ohio Columbus, Ohio Altavista, Virginia Singapore New plant last five years Source: Abbott Nutrition website; Abbott Nutrition 10k; various published articles and reports; Coriolis analysis PAGE 50 ABBOTT NUTRITION – LOCATION OF PLANTS Abbott Nutrition’s 14 manufacturing plants range in size; not all manufacturing plants produce all products Details of Abbott Nutritional plants around the world (2012 or as available) Region Nutritionals plant location Product # of employees at this location Year opened North America Altavista, Virginia Nutritional drinks 700 N/A Brockville, Canada Infant formula 160 N/A Strike in 2009; exports to 30 countries; being closed 2013/14 Casa Grande, Arizona Infant formula Nutritional drinks 425 1985 Added capacity in 2003 Columbus, Ohio Nutritional drinks TBD N/A Location of Nutrition division HQ Fairfield, California Various nutrition 200 N/A Sturgis, Michigan Various nutrition ~700 N/A “Insect part” driven product recall in 2010; lost US$100m Tipp City, Ohio Nutritional drinks 240 when open 2014 Produce nutritional drinks for US market Cootehill, Ireland Infant formula 120 1975 Established 1975; Abbott’s largest single IF factory Sligo, Ireland Enteral (tube) feeding TBD 1974 Established 1974 Granada, Spain Infant formula TBD [1994] Part of 1994 acquisition of Lacto Puleva’s nutrition division Zwolle, Netherlands Infant formula TBD N/A 30+ different food products produced Singapore Infant formula 200+ 2007 Singapore has no cows Guangzhou, China Infant formula TBD 2009 Appears to use 100% NZ milk powder Jiaxing, China Infant formula 300 when open 2014 New plant to serve Northern China market Europe Asia Source: Abbott Nutrition website; Abbott Nutrition 10k; various published articles and reports; Coriolis analysis Other available details PAGE 51 MODEL COST STRUCTURE – MANUFACTURER About a third (38%) of the ex-factory price of a can of infant formula goes to pay for the product, a third (38%) to operating costs and a seventh (16%) to shareholders and retained earnings MANUFACTURER MODEL: Estimated model of wholesale price (ex. local logistics) through to shareholders return of a can of infant formula sold S$; actual; 2012 Financials given here based primarily on the financial data of: Selling, general & administrative $6.28 20% Packaging $2.33 8% and Operating costs $11.53 38% Other ingredients $4.20 14% Cost of products sold 38% Total = $30.61/can Note: Not shown is an in-Singapore logistics charge of $0.31 Advertising & promotion $4.34 14% Gross margin 62% Research & development $0.75 2% Other expenses $0.16 0% Depreciation & amortisation $0.60 2% Dairy products $5.13 17% Income tax $1.51 5% Shareholders & retained earnings $4.81 16% Source: Abbott 10k 2012; Mead Johnson 10k 2012; past Coriolis research; Coriolis research & estimates Interest expense $0.51 2% EBITDA $7.43 24% Return on total assets (EBITDA/total assets) 29% 52 MODEL COST STRUCTURE – MANUFACTURER – SOURCES & KEY ASSUMPTIONS The model cost structure used for the manufacturing component of a 900g can of infant formula was built using the following sources and assumptions MANUFACTURER MODEL: Details of key elements and assumptions in model cost structure 2012/13 Issue Details Key data source(s) used - Mead Johnson Annual Report 2012 (Mead Johnson is the global #3 infant formula manufacturer and the only large listed pure-play multinational infant formula manufacturer (therefore its financials give the purest view of the cost structure of the industry) - Abbott 10k and Annual report 2012 (used to cross check Mead Johnson where possible - Nestle, Danone, Mead Johnson, & Abbott websites and promotional materials - Material from other infant formula manufacturers websites and advertising; various published articles - Industry interviews; guidance from reviewers Key assumptions - The overall P&L cost structure and profitability of an infant formula manufacturer can be used to represent pro rata the cost structure of a specific item (900g can) from sales value through to shareholder return - For a large multinational producer at scale, the cost of raw materials is ~45% dairy; 37% all other ingredients and 21% packaging - Sales consist of the net value of goods sold to customers, net of returns, discounts and sales taxes - We are assuming all dairy ingredients came from New Zealand; in practice all manufacturers in Singapore source dairy ingredients from a range of countries (i.e. reality is more complex) - Assuming net effect of payment terms Not modelled - Complex item level costs Transport from stage prior - Assuming dairy ingredients are received by ship into Singapore and delivered to the factory Assuming all costs ex-dock paid by manufacturer and included in given cost structure Ingredient dairy price is CIF Cost of insurance and freight for transport from New Zealand dock to Singapore is assumed to be the difference between NZ FOB ($/kg) and Singapore CIF ($/kg) 53 VALUE CHAIN: THE DAIRY PROCESSORS - KEY INGREDIENTS – DAIRY & OTHERWISE Infant formula contains a range of ingredients designed to mimic human breast milk as closely as possible; three key ingredients are dairy based (nonfat milk powder, whey protein and lactose) Key ingredients in infant formula 2013 Ingredient category Details Protein From cow’s milk that is processed to have a profile similar to human milk Nonfat milk powder Whey protein - Fats a blend of vegetable fats (including DHA/ARA) to replace bovine milk fat in order to better resemble the composition of human milk - High Oleic Safflower Oil Soy Oil Coconut Oil Carbohydrate generally lactose from cow’s milk Lactose - Vitamins, minerals & other ‘‘micronutrient’’ pre-mix that is blended into the product to meet the specific needs of the infant at a given age - Galactooligosaccharides (though made from lactose), C. Cohnii Oil, M. Alpina Oil, Beta-Carotene, Lutein, Lycopene, Ascorbic Acid, Soy Lecithin, Monoglycerides, Potassium Citrate, Calcium Carbonate, Potassium Chloride, Carageenan, Ferrous Sulfate, Magnesium Chloride, Choline Chloride, Choline Bitartrate, Taurine, m-Inositol, Calcium Phosphate, Zinc Sulfate, Potassium Phosphate, d-Alpha-Tocopheryl Acetate, Niacinamide, Calcium Pantothenate, L-Carnitine, Vitamin A Palmitate, Cupric Sulfate, Thiamine Chloride Hydrochloride, Riboflavin, Pyridoxine Hydrochloride, Folic Acid, Manganese Sulfate, Phylloquinone, Biotin, Sodium Selenate, Vitamin D3, Cyanocobalamin, Salt, Potassium Hydroxide, and Nucleotides (Adenosine 5’-Monophosphate, Cytidine 5’-Monophosphate, Disodium Guanosine 5’-Monophosphate, Disodium Uridine 5’-Monophosphate), others Source: Mead Johnson 10k 2012; Coriolis from various ingredient labels Key ingredients Dairy Non-dairy 54 SOURCE OF DAIRY INGREDIENTS Singapore sources these three key dairy ingredients from a range of developed countries; New Zealand is a major supplier, but certainly not the only supplier Total Singapore import value of three key dairy ingredients in infant formula by source country US$m; 2012 Non-fat milk powder (HS040210) Whey (HS040410) Other 11% USA 7% France 7% Germany 8% Other 16% New Zealand 36% Total imports = US$189m Source: UN Comtrade database (custom job); Coriolis classification and analysis New Zealand 22% Australia 6% Total imports = US$95m USA 42% Australia 31% Lactose (HS170219/170211) Germany 11% France 3% USA 83% New Zealand 1% Total imports = US$34m Other 1% Australia 14% Germany 0% France 1% 55 WESTLAND [For the purposes of this value chain we are assuming that…] the dairy products used in Fann’s can of infant formula came from Westland Co-operative dairy on the West Coast of the South Island of New Zealand Westland Milk Products factory in Hokitika, New Zealand 2012 Location: Key operations: Wet processing Evaporation Spray drying Blending Packaging Produced: Milk powder Milk proteins (whey, casein, other) Butter Colostrum, lactoferrin Milk fats Dairy nutritionals Brands: Westland Milk Products, Westgold, Westpro Ingredients, EasiYo Employment: 200+ people Volume: 515m litres of milk (2012) Suppliers: Source: photo credit (courtesy Westland); website; Westland website Hokitika New Zealand 330+ dairy farmers (Co-operative owners) 56 MODEL COST STRUCTURE – DAIRY PROCESSOR Almost 60% of the receipts of the dairy processor go to farmers; operational and administrative costs (e.g. advertising, R&D) are minimal (compare IF producer earlier) as Westland primarily produces commodities DAIRY PROCESSOR MODEL: Estimated model of return to dairy farmer through to shareholders return on the dairy component of a can of infant formula sold NZ$; actual; 2012 Financials given here based primarily on the financial data of: Other costs of sale $0.76 17% Wages & salaries $0.28 6% Administration expense $0.45 10% Other costs 19% Total = $4.60/processor Cost of sales 75% Distribution expense $0.15 3% Finance expense $0.05 EBITDA 1% Depreciation 6% $0.18 4% Shareholders $0.03 1% Income tax $0.01 0% Return on total assets (EBITDA/total assets) 9% Dairy farmers $2.69 58% Source: Westland annual report 2012; Coriolis classification and analysis 57 MODEL COST STRUCTURE – DAIRY PROCESSOR – SOURCES & KEY ASSUMPTIONS The model cost structure used for the dairy processor component of a 900g can of infant formula was built using the following sources and assumptions DAIRY PROCESSOR MODEL: Details of key elements and assumptions in model cost structure 2012/13 Issue Details Key data source(s) used - Key assumptions - The overall retail P&L cost structure and profitability of a dairy processor can be used to represent pro rata the cost structure of a specific item (IF ingredients) from sales value through to shareholder return - Sales consist of the net value of goods sold to customers, net of returns, discounts and sales taxes - We are assuming all dairy ingredients came from New Zealand (we are aware reality is more complex) - Assuming no Abbott/Singapore specific net effect of payment terms/letter of credit, etc. (i.e. no risk premium) - Assuming dairy ingredients are sold FOB New Zealand - Ingredient dairy price is FOB; in-market manufacturer pays CIF - Cost of insurance and freight for transport from New Zealand dock to Singapore is assumed to be the difference between NZ FOB ($/kg) and Philippines CIF ($/kg) Not modelled - Complex item level costs Transport from stage prior - Assuming all internal New Zealand transport costs paid by dairy processor and included in given cost structure (given distribution expense) Westland Annual Report 2012 (Westland is #2 New Zealand dairy processor by sales and volume) Westland website and promotional materials Checked against other key New Zealand dairy processor’s annual reports Other New Zealand dairy processor websites and advertising; various published articles Industry interviews; guidance from reviewers 58 VALUE CHAIN: A WEST COAST FARMER The milk that Westland processed was supplied by its 330+ co-operative shareholder farmers Location: # of dairy cows: 173,651 (132,716 in milk or calf) [June 2012] # of herds: 374 (464 total cows/herd; 355 cows/herd in milk) Area farmed: 67,364 effective hectares Cows/hectare: 2.6 Volume: 587m litres of milk Milk/herd: 1.57m litres Milk/cow: 4,423l/cow in milk (or 85 families buying 1L of milk per week) Suppliers: Source: photo credit (courtesy Westland); website West Coast region New Zealand 330+ dairy farmers (Co-operative owners) 59 MODEL COST STRUCTURE – DAIRY FARMER Slightly more than half (56%) of the farm gate price goes to costs; farm EBITDA margin is 44%, which is split amongst banks, shareholders and the government DAIRY FARMER MODEL: Estimated return to dairy farmer through to shareholders return on the dairy component of a can of infant formula sold NZ$; actual; 2012 Financials given here based primarily on the financial data from: Wages $0.30 11% Purchased feed $0.49 18% ACC $0.02 1% Animal health $0.08 3% Labour 12% Costs 44% Taxation $0.27 10% Return on total assets (EBITDA/total assets) 7% Total = $2.69/farmer Rates $0.02 1% Shareholders $0.38 14% Source: MPI Dairy Financial Model (uses Canterbury as West Coast not available on MPI website); Coriolis classification and analysis Fertiliser & lime $0.19 7% Regrassing, weed & pest $0.03 1% Vehicle/fuel Repairs and maint. $0.14 5% Electricity/Water $0.08 3% EBITDA 44% Depreciation $0.05 2% Breeding $0.04 2% Finance interest $0.45 17% $0.06 2% Other farm $0.03 1% Farm admin $0.03 1% Insurance $0.02 1% 60 MODEL COST STRUCTURE – DAIRY FARMER – SOURCES & KEY ASSUMPTIONS The model cost structure used for the dairy farmer component of a 900g can of infant formula was built using the following sources and assumptions DAIRY FARMER MODEL: Details of key elements and assumptions in model cost structure 2012/13 Issue Details Key data source(s) used - New Zealand Ministry for Primary Industries (MPI) Farm Monitoring 2012 Canterbury dairy report - Checked against other New Zealand dairy regions and national - Industry interviews; guidance from reviewers Key assumptions - A model Canterbury dairy farm can be used as a model West Coast dairy farm (as MPI does not produce a West Coast Model); perhaps it is a new supplier to Westland’s Canterbury expansion - Dairy farmer is a member shareholder of a co-operative dairy company - Assuming dairy collection is paid out of dairy processor P&L - The overall retail P&L cost structure and profitability of a dairy farmer can be used to represent pro rata the cost structure of a specific item (900g can of infant formula) from sales value through to shareholder return Not modelled - Relative profitability of components of raw milk, both those that go into infant formula and those sold elsewhere - Complex item level costs Transport from stage prior - None 61 VALUE CHAIN – ALTERNATIVE SCENARIO – MULTINATIONAL PRODUCTION IN NZ If the multinational moved production of the infant formula to New Zealand (the alternative scenario), we project the new value chain as follows; the key change is more value added in New Zealand Value chain of a can of infant formula through to farm gate value in New Zealand: base and alternative scenario NZ$; actual; 2012 $47.50 $47.50 $3.33 $3.33 GST Alternative Scenario: Multinational moves production to New Zealand Concept Retailer $25.58 $0.31 In market logistics $12.79 $0.31 Manufacturer Sales, marketing, overhead, etc. $0.43 $9.21 What stays the same? - Same manufacturer - Same retail price Outcomes for New Zealand - Investment in a new infant formula factory (US$250-300m) - Imports of non-dairy IF ingredients increase - Exports of infant formula increase - Reduce double shipping - Potential to label “product of New Zealand” Arguments against - Distance to market (speed to market, etc.) - Shipping cardboard and packaging (rather than bulk powder) - Tariff and trade barriers into some markets - Treating freight as a wash (higher volume from NZ offset by no double shipping from Singapore onward to other markets) - Roughly 50% of manufacturer costs stays in NZ (materials plus half of SGA); not factored for increased imports - All ingredients other than dairy are imported Shipping & insurance Manufacturer Production in NZ - Location of production Key assumptions $13.25 What changes? Arguments for $13.25 - Global multinational moves some of its global production of infant formula to New Zealand by building a plant in the country $3.58 Imported ingredients $1.91 Dairy processor $2.69 $2.69 Dairy farmer Base Value Chain Alternative Scenario $0.43 $1.91 Source: Coriolis 62 Coriolis Limited PO Box 90-509 Auckland, New Zealand Tel: +64 9 623 1848 www.coriolisresearch.com